A decade ago this entry chronicling the incredible chase for the UK’s NCP Group’s car parks by
private equity was published. Macquarie, it was suggested, would repent long
for their poor timing and dear price paid.

What was the denouement?

Having paid £790m for it in
2007 Macquarie held NCP in its Guernsey-registered MEIF 2 structure. MEIF 2 was backed by
institutional investors mainly, it appears, pension funds.

Macquarie then
watched the economy melt in the heat of the credit crunch, the congestion charge in London eat into parking demand
and the servicing of the £500m debt it took on to finance the deal become impossible to
meet.

By 2012, despite at
least two capital increases from Macquarie, net liabilities at NCP rose to over
£634m. Pre-tax losses reigned and NCP’s debt on the secondary loan
market was trading at under 15% of face value. With loan covenants under threat
protracted negotiations with lenders and the majority landlord (one set of prior owners
- Cinven - having sold and leased back the entire property portfolio) led to a
rescue deal.

At what cost? Lenders
wrote off £349m of loans in exchange for 15% of NCP’s equity; the landlord,
Israeli firm Delek under pressure from its own bankers, reduced rents by £10.5m
per annum on the understanding that the deal would sort out the long term debt quandary
of NCP; and Macquarie recapitalized NCP by another £50m – on top of writing off
£298m of its own loans.

That comes to the tidy sum of £697m. But at least it stopped the rot, right? Erm, sort of.

Last December a
further refinancing closed. With NCP then showing net profit around £28m
on turnover of £227m Macquarie had sought to refinance a £140m loan package. They settled for £115m and the injection of another £20m of their own capital to
make up the difference.

The balance sheet is now healthy but
Macquarie's MEIF 2 was designed to invest in businesses that “generate stable cash
flows over the long term”. That label for NCP may no longer be
viable.

When it
was acquired in 2007 NCP turned over north of £300m for the car park piece of the deal that
Macquarie bought (vendor 3i having stripped out the services business for themselves). That has slid to £203m as of March, 2016. Can it be increased or at
least held steady? Maybe - but it is worth noting that the market value of the properties leased by Macquarie represent an ongoing threat to the effort.

In September, 2016
Blackstone sold 88 NCP sites for £500m. Some of these are clearly more profitable
as conversion and development assets. There is a precedent in the single West
End site Blackstone sold in 2015 for around £70m. Although the lease in that case
runs to 2037 – not very far away for a pension fund investor - it was acquired
primarily to end a planning dispute over a neighbouring luxury residential
development owned by the same buyer. Comparable deals will erode NCP revenue
sources.

With the debt side
stable and £187m of net assets now on the balance sheet a sensible course of action in a fragmented European parking market would be to offload NCP to a specialist, stable competitor looking for greater scale. The Netherlands' Q-Park, Spain's Empark or France's Vinci Park fit the bill - and each already has a UK presence.

“It is usually agreed that casinos should, in the public
interest, be inaccessible and expensive. And perhaps the same is true of
Stock Exchanges. That the sins of the London Stock Exchange are less
than those of Wall Street may be due, not so much to differences in
national character, as to the fact that to the average Englishman
Throgmorton Street is, compared with Wall Street to the average
American, inaccessible and very expensive”

Times change and when JM Keynes wrote that in The General Theory of Employment, Interest and Money he did not anticipate the rise of bookmakers like William Hill, Ladbrokes, BetFair/Paddy Power and so forth.

Combined
with the power of the internet and idiot-proof betting and trading
algos (which is not a comment on the effectiveness of those same algos)
the behaviour of the share prices of these companies came to bear an uncanny resemblance
to that of the London Stock Exchange (LSE).

Here, for example, is a plot of the William Hill (in red) vs LSE share price between April 2009 and July 2013:

Very positive correlation. It brings to mind the the more famous casino quote from chapter 12 of The General Theory:

“When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done”

What, then, to make of the same graphic (with LSE now in red) since August 2013?

Now they show negative correlation. All clear sailing ahead?

It
is perhaps a sector comment (for this is not limited to William Hill) and nothing more. But given that the DNA of
the modern bookmaker is now part-bourse (they take financial wagers in
addition to bets on just about anything else) it gives pause for thought
on the possible future direction of the broader market.

After all, central bank actions have not bestowed the same benefits on the clients of bookmakers that they have on those of stock markets.

It is sometimes easy to treat economic policy in the abstract and overlook its human cost. Or make claims involving the Greater Good. Such claims always merit close scrutiny. This Bloomberg piece by Narayana Kocherlakota, former president of the Federal Reserve Bank of Minneapolis touched that nerve.

Negative rates provide as many questions as answers. But some things are clear. "Almost" retirees looking at annuity rates are major losers. As are serial savers, poor fools. Thrift is not cool, Aesop.

So we are to pay banks to guard our savings. And be paid to borrow - which, by the way, is already the case for some borrowers in Sweden and Denmark.

House prices love it. Small Scandinavian children, bewildered, are asking "You mean the bank pays us to spend their money, Daddy?" Yes, my child. Well, not "their" money. But that's another story ("Cinderella can't figure out how to debase the krone").

Banks, whatever one thinks of them, are not universally looking like they want to play along and "understand and fully support" Mr. Kocherlakota's message. Here's a report that Commerzbank is considering simply hoarding the cash - rather than lending it - to
get away from ECB negative rates.

Does it imply cultural changes to spending behaviour? Clearly. But mostly it exasperates and lends fodder to either edge of the political spectrum. Policy is pursued, essentially, through currency manipulation.

Unfortunately, the current ZIRP / NIRP novelty of this path presents insurmountable obstacles to widespread capital stock formation and investment. Encouraging that, once upon a time, was how serious policy sought to improve productivity and create growth.

Novelty means uncertainty. Calculating the net present value of capital investment projects becomes more of a gamble than it is worth in such a context. Projected depreciation, debt servicing, revenues and costs are all affected (unequally and potentially profoundly) depending on the inflation (or deflation) assumptions assumed.

Why gamble when central banks are experimenting? Defer or displace activity somewhere steadier. Concurrently, don't forget to take the money on offer, employ financial engineers and "invest" in your own shares instead:

If tomorrow there was a sand shortage in the Sahara it would befuddle many. A close second is how after many years of expensive oil prices Venezulea (highest proven reserves in the world) is now asking the ladies to stop using hairdryers so that the country can negotiate an awful energy shortage. How did they get here?

The short answer is most electricity capacity in Venezuela comes from hydro - and the country is suffering drought. So blame El Niño (as President Maduro does).

The longer answer is a striking lack of investment in power capacity: despite the knowledge that consumption has risen by half over the 10 years to 2012 planners have engineered an increase in capacity of under 30%. Cue a negative externality and pleas for wet hair ensue.

In what appears to be a story of deferred pain, investment by the private sector electricity companies (and others) dried up when the late President Chávez was elected in 1998. Subsequent nationalization actions did not encourage private capital. Concurrently, consumption subsidies and price freezes on electricity boosted demand.

Told this way current travails appear more a case of poor economic management by socialists.

However, dig a bit and it is perhaps most accurately a story of a divisive political history and corruption stretching back to (at least) the nationalization of oil companies in the mid-1970s. With the subsequent oil price shock in 1978 the Venezuelan economy became a very fine example of Dutch Disease.

Arguably the key consequence of a four-fold increase in government revenue following the OPEC prices rises was an increasing cancer of corruption eating into the two dominant political parties of the day. Worsening cronyism and patronage in electoral competition became the norm; and this in time led to Hugo Chávez coming to power on the very reasonable manifesto of anti-patronage, anti-corruption and anti-poverty.So, as with statistics, the cause (and answer) to the problem depends on which section of the time-series one starts the analysis from.

Keeping in similar vein to a number of the previous entries about the
mysteries of defining, selecting and tracking hedge fund strategies here is a
2015 paper by Swiss wealth manager Pictet titled “Hedge
fund indices: how representative are they?”

Amongst its gems covering the biases of the indices is this great graphic
explaining the source of ‘self-selection’ bias:

Core message: less than one percent of funds report to all the tracking
databases. One study puts the impact on the performance figures of this at 1.9%
per annum. More worryingly, the cumulative impact of all biases may be as high
as 10.7% annually.

Over time that adds up to a lot of dispersion between index providers...

An earlier entry pointed out how many sub-strategies there are under the title ‘long/short’. Take one step back and consider this table from the 2016 Preqin Global Hedge Fund Report (click for larger version):

The table continues for an entire second page but this half makes the point: that’s a lot of strategies before any examination of sub-strategies.

For those who like steady returns with as few shocks as possible ranking this list by the 5 year net return/volatility columns produces is a clear winner in the equity class: RV Equity Market Neutral (our yellow highlight). It is not the best on that ratio overall: two credit based approaches formerly best known for Jenga cameos in The Big Short pipped it.

The top 10 strategies on the return/volatility ratio look like this (click for larger version):

If drawdown is your nemisis the list may be useful reference point when selecting approach.

One of the problematic aspects of such an approach is that “long/short” is a hard category to define – and there is no consensus around the term. Which leaves plenty of room for whatever headline one wishes to shock and amaze with.

The IAM took a stab at the definition in cooperation with the LSE's Financial markets Group a few years ago. They produced the following classification table of hedge fund strategies:

A cursory examination will show that Long/Short is a broad church. And complicating matters are those of its disciples who regularly trek over to the neighbouring tabernacle of Relative Value to worship.

Thus probably it is worth defining precisely what class of strategy is being analyzed before daubing all L/S with the same brush.

“Just buying
cheap stocks doesn’t do you any good unless they get less cheap soon”

So consider value as an investment category. Words to the
effect that “the market always recognises the economic fundamentals of sound
enterprises in due course” are part of the strap lines of value managers:
intrinsic value against market prices; 60 cents for a dollar; and so on.

In overvalued and irrationally exuberant markets this
approach frequently provides poor returns relative to benchmarks as market
participants suspend good sense. Still, after the fallout of such episodes the
value manager’s reputation as a paragon of sober logic is burnished.

And thus the proposition that the oft mad market will come
round and fully price the fundamentals of a value enterprise remains seductive.
So much so that the possibility of the fundamentals
coming round to align with prices is frequently overlooked.

Yes, time does not heal all mispricings. Much can (and does)
go wrong as it elapses - and as the architecture of financial markets evolves.

Last week, for example, Francis Chou was reported by
Bloomberg as returning his 2015 advisory fee in an act of solidarity with his investors who lost 22% in
his Opportunity Fund. Mr. Chou had a poor 2015 but, historically, is a strong
value manager - as he points out in the article by referring to his great long-term
record. Nonetheless, 22% is quite a drawdown to ascend in reasonable time
without taking excessive risks.

An outlier? Some readers may be thinking “Warren Buffet”
just about now.Below is a chart of
Berkshire Hathaway’s performance versus the S&P 500 on a rolling 5 year
basis.

Source: Berkshire Hathaway annual letter, 2015

Even the King of Value has found the job tougher and tougher
since the turn of the century.

Sadly, stability is not a characteristic of any such factors.
Their very popularity will see to that; and if it does not anything else
leading to a change in market regime will. So “smart” should more accurately be
called “alternative” (or even “dumb”).

Indeed, at least one study has shown they do not outperform
their benchmarks on a risk-adjusted basis.

Alternative beta is no substitute to dynamic (and
proprietary) strategies. Such approaches continuously monitor changes in
relationships and shift to the most profitable. If you have one keep it
proprietary!

Plagiarists & Pirates note...

Copyright since 2004, Rawdon Adams.
All Rights Reserved.

Credo

"The game of professional investment is intolerably boring and overexacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll"

- JM Keynes, The General Theory of Employment, Interest and Money, 1936. I forget which page.

Man cannot live by bread alone

Disclaimer

Capital Chronicle does not sell investment advice. You may wish to consider what you read on this site in any decision to invest your capital; all content is offered in good faith; and data sources used are regarded as trustworthy. But mistakes can happen and in no circumstances ought you to regard views herein as solicitations to undertake any investment actions.

Disclosure

Capital Chronicle writers say when they have a financial interest in the topics they cover. They don't when they don't.